Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by the

Department for International Development

Introduction

1. The tax system is at the heart of an effective state. Domestic tax revenues provide sustainable funding for essential public services and transfer payments. Funding requirements for reducing poverty and improving physical and social infrastructure are substantial. But how taxes are raised, not just how much is raised or how it is spent matters greatly for reducing poverty, promoting growth, and improving governance. Taxes shape economic growth by altering the incentives for work, investment, saving and innovation. Taxation is a core part of state-building and the most visible sign of the social contract or "fiscal compact" between citizens and the state. Fair and transparent tax collection promotes social cohesion and shapes government legitimacy by promoting accountability of governments to tax-paying citizens, and by stimulating effective state administration and good public financial management.

2. Good tax systems strive to be economically efficient (raising revenue while creating optimal incentives in favour of "goods" such as work and investment and against "bads" such as pollution); effective (capable of delivering the desired objectives at minimum administrative and compliance cost); and equitable (offering fair treatment of taxpayers and promoting social cohesion). These objectives may not always align (for example consumption taxes may be economically efficient but regressive in their incidence). Tax revenue can be increased by broadening the tax base, increasing taxable activities (i.e. economic growth), improving compliance (i.e. improving enrolment and collection as well as reducing evasion and avoidance), or raising rates; although high rates can also dampen growth and reduce the incentives for compliance.

3. In many developing countries tax collection is low as a percentage of GDP, as a percentage of tax owed and in terms of participation rates
[1]
. The tax base is often overly narrow, for example many developing countries have large informal economies, and property taxes are rare. Tax administrations may be ineffective, coercive or susceptible to corruption, while governments may undermine their own tax base with inappropriate exemptions and concessions. Oversight by parliaments, national audit bodies and other institutions may be weak or absent. Taxpayers may have limited rights of redress or the courts may be incapable of fair and effective dispute resolution. "Tax morale" may be low: if citizens think taxation is excessive or revenue will be lost to corruption they will be less likely to pay; small firms could move into or remain in the informal sector, which carries its own costs. Poorly designed policies and systems may deter investment, innovation and employment and impede the economic growth that is ultimately the most important driver of sustainable revenue flows.

4. The extraction of natural resources poses specific challenges for taxation and public financial management. These challenges can be particularly serious for countries which are poor despite abundant natural resources. Countries with natural resource wealth are likely to need to promote investment in what is a highly capital-intensive sector but at the same to be able to capture the economic rent generated, which, when managed properly, has the potential to transform the public finances, the economy and the lives of the poor. In extreme cases, however, where the revenues from natural resources are particularly large and badly managed, the fiscal compact between government and citizens can be undermined to the extent that a "rentier state" develops (for example Libya under Gaddafi). In such cases, political elites, having captured the resource rents, neglect the wider tax system and consolidate power through patronage and repression. Citizens come to see the state as at best a source of meagre handouts rather than a provider of public services funded by taxation.

5. Sustainable economic growth driving rising tax revenues is the eventual exit strategy from aid dependency for developing countries. Tax is central to the ‘Monterrey Consensus’ agreed in 2002 and reaffirmed in 2008, by which developing countries committed themselves to deliver "effective, efficient, transparent and accountable" taxation systems, in return for increased international development assistance. Most recently, the Busan High Level Forum (2011) reiterated the commitment to domestic resource mobilisation, and revenue falls within one of the five Peace-building and State-building Goals of the New Deal for Engagement in Fragile States, endorsed in Busan. The G20 Development Working Group, and the Organisation for Economic Cooperation and Development (OECD), in particular through the Task Force on Tax and Development, have also held extensive discussions recently on taxation and domestic resource mobilisation in developing countries.

Question 1: How DFID can better support developing countries to improve revenue collection

6. DFID helps to improve revenue collection in developing countries through demand-led assistance projects at the country level, which may focus specifically on strengthening the revenue collection function, or may have broader objectives. Country level work is complemented by engagement in international processes and support for international organisations and for research.

7. Between 2006/07 and 2010/11, DFID spent approximately £ 97 million on helping to improve revenue collection. Annex A provides information on this spending. Annex B gives an overview of DFID’s main current or recent tax related projects, which range from large complex programmes down to very short, targeted interventions.

8. For example, in Burundi, through a regional programme, DFID helped to establish an independent Revenue Authority in July 2010, at a time when the country's tax and customs services (then under the Ministry of Finance) topped the list of East Africa's most corrupt organisations in Transparency International's East African Bribery Index. The programme set out to transform the culture of tax collection. From January to June 2011, revenue collection was 37.4% above the level for the same period the previous year. From July to September 2011 the outturn revenue exceeded the forecast by 14 percent (or £7million).

9. DFID support to the Rwanda Revenue Authority helped to provide the laws and regulations under which the authority was established, the office building and the management systems. The 10 year period of support saw a six-foldincrease in the taxes collected and in 2010, the management procedures of the authority were awarded ISO 9001 2008 accreditation – the first Rwandan institution to attain this standard. The Authority reached a point where it was collecting the full £24 million value of DFID’s support programme every three weeks. Its effectiveness has been a major factor in Rwanda’s impressive development performance in recent years.

10. DFID has provided support for tax reform in Afghanistan, where domestic revenue collection reached a high of 11.2% of GDP in 2010/11. DFID is continuing to provide technical assistance to assist the Afghanistan Revenue Department to increase revenue collection from 2011 to 2015.

11. In Ethiopia, DFID, alongside other donors, supports the Public Sector Capacity Building Programme which includes capacity building support to the tax system. An objective is to increase tax revenue by 87% from 43.3 billion birr in 2010 to 81.1 billion birr in 2013
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.

12. In Nigeria, DFID is supporting the ‘Growth and Employment in States’ (GEMS) project which runs from 2010 to 2015. This focuses on the value chain and business environment, as well as land reform and investment policy, and includes an estimated £9 million related to taxation.

13. In Zambia, DFID has extended its support to the multi-donor Public Expenditure Management and Financial Accountability program, providing an additional £2.2million from 2011 to 2013. The programme extension includes a component to strengthen tax administration at the Zambia Revenue Authority, with the objective of reversing the recent decline in the non-mining tax to GDP ratio.

14. Projects reflect individual country circumstances, including the extent to which needs may already be met by other donors and international organisations. Coordination of donor support is important. Country ownership and political support are critical to success. Support for revenue collection may be part of broader public finance management or public sector capacity building programmes. DFID often works in partnership with international organisations and other donors, as is the case, for example, in Mozambique and Tanzania, or coordinates with their efforts. For example in Bangladesh the DFID funded Tax Administration Compliance and Taxpayer Services programme is being implemented at the same time as a major reform of tax policy supported by the International Monetary Fund (IMF), which includes an overhaul and updating of income tax and VAT legislation.

15. HM Revenue and Customs (HMRC) also supports projects to enhance the capacity of tax administrations in developing countries, delivering assistance on a bilateral basis and through multilateral forums, either working with DFID or independently. Bilateral initiatives include a long-term partnership with the Ethiopian Revenue and Customs Authority. Under this twinning programme, HMRC provides technical assistance, aligned to the strategic needs of the Ethiopian Government, on both customs and tax. HMRC also has an ongoing senior-level relationship with Rwanda Revenue Authority: the Permanent Secretary mentors the Commissioner General and HMRC is delivering targeted technical assistance to support Rwanda’s modernisation programme. Each year, HMRC hosts and runs two flagship training courses on behalf of the Commonwealth Association of Tax Administrators. The courses are designed to develop management capability and technical skills and are attended by senior managers and tax inspectors, primarily from developing countries in the Commonwealth. To promote the sharing of best practice and encourage skills transfer HMRC regularly welcomes visiting delegations from developing countries and also supports inward and outward secondments of specialist staff.

16. The recently established Investment Facility to Utilise UK Specialist Expertise (iFUSE) facility is a further route through which HMRC expertise can be provided to partner countries for short technical assistance projects. iFUSE became operational in January 2012. It is a platform which will facilitate the provision of support by experienced policy practitioners from UK Government Departments to their counterparts in developing countries.

17. The IMF is an important provider of technical assistance on revenue. HMRC supports the IMF’s outreach work with developing countries through the delivery of targeted technical assistance. DFID contributes funding to three of the IMF regional technical assistance centres. These centres provide technical assistance on tax as well as other financial and economic management issues to countries in the regions which they cover.

18. The Investment Climate Facility for Africa
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, which the UK funds alongside a number of other donors, is an important source of technical assistance, with tax and customs reform established as one of its main priorities. DFID is also providing support to the World Bank Group’s Foreign Investment Advisory Service (FIAS), which works to strengthen the business environment in developing countries. This involves helping developing countries to remove tax barriers to growth and investment and to widen the tax base through greater inclusion. During 2008 to 2011, FIAS has made a contribution to 49 reforms of business taxation systems in countries around the world (of which 34 where in Sub-Saharan Africa).

19. UK support in the area of taxation and domestic revenue mobilisation is not confined to capacity-building at the country level. An important part of of our approach is improving the enabling environment for developing countries in the area of taxation, including through international initiatives, networking and research. In this way, the UK can exert influence and achieve impact beyond what could be achieved by working at the country level alone. The UK has actively participated in discussions on taxation and domestic resource mobilisation in an increasing number of international forums, including the G20, which are key in areas where progress is determined at an international level.

20. The UK has been involved with the African Tax Administrators’ Forum (ATAF)
[4]
since its inception and DFID is one of its largest single donors. ATAF is becoming increasingly effective on behalf of its member tax authorities, representing them on the international stage, engaging with donors, coordinating technical assistance and fostering peer-to-peer learning between members. HMRC has also supported ATAF through in depth assistance in the field of transfer pricing to member countries.

21. DFID has funded the International Tax Dialogue
[5]
, a forum for tax and development specialists, in particular to work with ATAF on a project comparing key aspects of revenue administrations in 15 revenue authorities in Sub-Saharan Africa.

22. UK has also been involved in the OECD Tax and Development Task Force
[6]
since its inception. DFID part-funds the Task Force in which it is an active participant alongside HM Treasury and HMRC. The Task Force is an unusual forum in that it is composed of representatives of donor countries, developing countries, business and Non-Governmental Organisations (NGOs) who together discuss ways to make progress on a range of important tax-related issues: the four pillars of its work are tax and state-building, tax transparency and exchange of tax information, transfer pricing and corporate reporting. Most recently the Task Force has agreed to look at how best to promote transparency around the granting and management of tax incentives, such as tax holidays, which can undermine the revenue base. This is a key emerging issue for developing countries.

23. HMRC is an active participant in the OECD work-streams and outreach training programmes, which support developing countries. HMRC is leading a project involving Uganda, Nigeria and South Africa on improving the efficiency of transfer pricing audits.

24. The G20 is the most recent forum to become involved in tax and development issues. There are two strands to this – firstly around tax transparency and exchange of information, where the UK has consistently sought to keep the interests of developing countries in focus in the remit given by the G20 to the Global Forum on Transparency and Exchange of Information. Secondly and more recently, domestic resource mobilisation was included as part of the G20 Development Action Plan. This work was itself in two parts, the first on general capacity building issues and the second on tax transparency and exchange of information, both of which are reflected in the commitments made in the Cannes G20 summit communiqué and the separate report to the summit from the Development Working Group. DFID was involved in both parts of this work through the Development Working Group and, in the latter through participation in the Advisory Panel to the Global Forum on Tax Transparency. DFID was the only development ministry on the Panel.

25. DFID has a strong commitment to commissioning world class research and ensuring that it is readily available to those who can use it. DFID also aims to use the best evidence, from any source, in its own decisions, and to evaluate programmes in order to learn lessons. DFID is providing £3.5 million funding for a five-year research programme consortium; The International Centre for Taxation and Development. This programme was commissioned to provide evidence on how best to strengthen taxation reform in developing countries. Previous DFID-funded, and other, research showed that better evidence was required to find the best ways to promote the effective, efficient and equitable tax systems needed to deliver development in developing – particularly low-income and fragile – states. Research outputs have the potential to exert significant influence on tax reform undertaken by developing country governments as well as on capacity building and technical assistance projects undertaken by DFID and other development agencies.

26. Ultimately, tax revenue is heavily dependent on the economy. Economic growth is a major factor in increasing tax revenue. The UK supports countries to achieve sustainable and inclusive economic growth through its bilateral country programmes, regional programmes, and by influencing both the multilateral organisations which it supports and the wider international community. This work includes helping to improve countries’ economic policies, improving countries’ openness to trade, promoting private sector development, improving the business environment, improving access to financial services, enhancing infrastructure, helping value and manage natural assets, reducing inequality of economic opportunity and supporting low carbon and climate resilient investment. For example DFID funds the International Growth Centre which provides independent growth policy advice to senior policy makers in developing countries.

Question 2: How DFID can support developing countries to use the revenue base responsibly in order to improve service delivery and development outcomes

27. Governments use their revenues to deliver services and development outcomes through their Public Financial Management (PFM) systems – the systems through which revenue is raised and funds are allocated and spent. These systems, which should ensure fiscal discipline, strategic allocation of resources and value for money in service delivery, are weak in many developing countries. Improving them can lead to better service delivery and development outcomes.

28. Aid is only a part of total government spending in DFID partner countries, and in some of these countries only a small part. Spending aid well is important, but improving PFM can lead to better use of all funds, not just aid. DFID expects its partner governments to be committed to improving PFM.

29. DFID helps to improve PFM in developing countries by providing technical assistance to partner countries, through dialogue and through international initiatives. DFID is helping to improve PFM systems in many of its partner countries. For example: DFID funded the UK National Audit Office (NAO) to assist the State Audit of Vietnam to turn its Strategic Plan into a more detailed Development Action Plan. The Plan was approved and implementation started in early 2011. With the United Nations Development Programme (UNDP) and the European Union (EU), DFID is supporting the Supreme Audit Institution of the Democratic Republic of Congo. In 2010, audit reports for 2005, 2006 and 2007 were produced. Anti-corruption Non-Government Organisations (NGOs) have started to use audit reports and demand more control over public spending. From 2007 to 2009, DFID supported the Ghanaian Public Accounts Committee (PAC), including through training the media and providing finance for public sittings. Broadcasting hearings on radio and TV got people talking about corruption and the standard of questions and answers improved.

30. The coalition government has given particular emphasis to achieving results and value for money and to improving transparency and accountability. This is reflected in changes in our approach to budget support. The commitments we expect of our partner governments now include improving accountability to their citizens. Where we provide budget support, we expect this commitment to include a credible programme to improve the Supreme Audit Institution and related parliamentary oversight.

31. Ensuring people have access to information on government spending and are able to make their voices heard can be a powerful way of improving resource use. In Uganda, communities using scorecards to feedback on their experience of health services had 33% fewer child deaths
[7]
. In India, social audits and public meetings have driven down corruption in the rural employment guarantee scheme
[8]
. DFID is committed to expanding people’s choice and helping to empower them to hold their governments to account. DFID will help citizens monitor government services using citizen report cards in Mozambique and Rwanda. In Bosnia, DFID supported civil society organisations to analyse the national budget and advocate for more transparent reporting. DFID is exploring how new technologies can help people monitor service provision and drive up performance through programmes in India and Tanzania.

32. DFID’s strengthened approach to budget support includes a commitment to spend, across budget support countries, an amount equivalent to 5% of budget support on strengthening domestic accountability institutions. We have increased citizen engagement in budget support dialogue in a number of our budget support countries. In Sierra Leone, DFID is supporting civil society to scrutinise the government budget and communicate and disseminate findings to the wider public.

33. DFID is also introducing innovations to the design of budget support programmes, to give more emphasis to results and reforms. Arrangements whereby a part of budget support funds is contingent on results achieved have been introduced or are planned for a number countries, such as Uganda where this will apply to 30% of DFID budget support in 2012/3.

34. Our work at the country level is complemented by support for international initiatives. These include the Public Expenditure and Financial Accountability (PEFA) programme; a joint venture between three multilateral and four bilateral development agencies. A PFM performance measurement framework has been developed and has now been applied in over 120 countries. It provides an objective basis for assessing standards of PFM and, as countries carry out repeat assessments, for monitoring progress. Individual country assessments help to determine priorities for reform, whilst, collectively, the assessments provide an evidence base for research.

35. Supreme Audit Institutions (SAIs) help to hold governments to account for use of public funds. Where they are effective, their work is likely to deter fraud and corruption and may be a catalyst for system improvements. The International Organisation of Supreme Audit Institutions (INTOSAI) is an independent, worldwide body, to which the vast majority of SAIs belong. It provides a structure through which more can be achieved than just by working with individual SAIs. The World Bank and DFID are Chair and Vice Chair respectively for the donor group in a partnership with INTOSAI, established in 2009. Work is already underway on a databank of support to SAIs, a pooled funding mechanism and a tool for assessing SAI performance.

36. At the fourth High Level Forum on Aid Effectiveness in Busan in November 2011, the UK Government pushed for a stronger focus on results and transparency. This is reflected in the outcomes which include new shared principles on (a) the need to focus efforts internationally on achieving results, and (b) the importance of transparency as a basis for enhanced accountability – including an agreement to focus on establishing transparent public financial management and aid information management systems. This should help to ensure a focus on the effectiveness of institutions and policies that promote development, and not just on aid.

37. By working at the country and the international level, in partnership with others, DFID is helping to improve PFM, including the way funds are raised and spent. Evidence from PEFA assessments indicates a broadly positive trajectory of change
[9]
.

38. Improving compliance requires not only tackling deliberate evasion and avoidance
[10]
but also ensuring that taxpayers find the process straightforward and are convinced that their taxes are well spent (i.e. "tax morale" is high). Authorities need to help those willing to pay their taxes as well as making it difficult for those that want to escape their liabilities.

39. "Tax gaps" – the difference between the theoretical tax take given 100% compliance and the actual tax take – are notoriously difficult to estimate accurately. Where OECD countries have undertaken this exercise they have found it challenging despite the availability of some high-quality data. Estimates for developing countries of tax gaps and "illicit flows" (which include losses to evasion) have proved particularly controversial and face considerable data and methodological challenges. A report
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commissioned by DFID concluded that most such estimates are not reliable. Nevertheless, the fact remains that just as tax authorities will struggle where tax morale is low, those that lack capacity and technical skills, or which operate with legislation that is inadequate, will be especially vulnerable to evasion and avoidance.

40. Once tax policy has been determined, compliance is ultimately the core function of any revenue authority. Capacity building projects supported by DFID include a range of interventions that are directly or indirectly related to compliance, evasion and avoidance. For example, the large taxpayer units, which DFID funded projects have supported (in Bangladesh, Mozambique, Sierra Leone and Tanzania, for example) are designed to be centres of expertise for dealing with large organisations efficiently and effectively. In other cases DFID is supporting the improvement of tax legislation (for example Afghanistan) or strengthening audit (for example in Rwanda).

41. The taxation of companies and individuals with operations or assets in multiple jurisdictions poses particular challenges for revenue authorities. The network of tax authorities willing and able to exchange tax information to allow the proper assessment of tax liabilities was quite limited until relatively recently. The request by the G20 for the Global Forum on Tax Transparency and Exchange of Information for Tax Purposes to redouble its efforts in this regard has seen a huge increase in the number of tax information exchange agreements, although as yet relatively few involve developing countries
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.

42. The UK has consistently sought to keep the interests of developing countries in focus through the G20-Global Forum process and encourages developing countries to consider joining the Global Forum. DFID, HM Treasury and HMRC have been directly involved in promoting tax information exchange in three further, important ways. First, as discussed under question 1, DFID was part of the Advisory Panel to the Global Forum which took forward work on Part II of the Domestic Resource Mobilisation pillar of the Seoul Development Action Plan
[13]
. The report prepared by the Panel was adopted by the Global Forum and was the key input to the Development Working Group discussions on this topic and the commitments made by the G20 in this area are now being taken forward by the Global Forum, including, for example, establishing a platform to coordinate technical assistance on exchange of information.

43. Secondly, DFID has recently provided funding for the Global Forum secretariat to provide technical assistance to the revenue authorities of Kenya and Ghana to enable them to participate fully in international tax information exchange. The UK is the first donor to support a specific technical assistance project in this field, the aim being that it should act as a "pathfinder" for developing countries and donors alike.

44. Thirdly, in addition to bilateral tax information exchange treaties, the Convention on Mutual Administrative Assistance in Tax Matters now offers a means for multilateral information exchange (i.e. by becoming a party to the Convention, a country has a treaty basis for information exchange with all other parties) as well as other forms of cooperation. One of the Government's first acts on coming into office was to sign up to a new Protocol that brought the Convention into line with international tax information exchange standards and opened it up beyond OECD and Council of Europe countries to a potentially worldwide membership. The Coordinating Body of signatories to the Convention, which oversees invitations to join, has, with encouragement from the UK, stated that it would welcome expressions of interest from developing countries. The UK also pressed for all G20 members who had not already done so to sign up to the Convention, which they did at the Cannes G20 Summit.

45. Transfer pricing has become the focus of considerable attention in recent years in the context of the taxation of multinational enterprises. Incorrect transfer pricing can shift profits from high-tax to low-tax jurisdictions and abuse of transfer pricing is regarded by some as being the single largest contributor to cross-border tax evasion. Transfer pricing is, however, often a matter of judgement, with alternative views of the correct price of individual transactions.

46. The term "transfer pricing abuse" is often used incorrectly to encompass all manner of international tax avoidance structures or devices. It is important to realise that improving the ability of revenue authorities to deal with transfer pricing will not address all problems of losses through such structures. Measures to address developing country needs related to transfer pricing should be planned in the context of the countries’ wider capacity building and reform efforts, including more general anti-avoidance work. Appropriate prioritisation and sequencing is required to ensure that work on essential but less high-profile issues is not displaced.

47. Within DFID programs, work on transfer pricing and related compliance functions may be part of Large Taxpayer Unit projects, as for example is the case in Bangladesh. In addition, the OECD Tax and Development Task Force (see response to Question 1) has taken transfer pricing, and in particular the needs of developing countries wishing to improve their capabilities in this area, as one of its four workstreams. From this has come a recent project by the OECD to provide technical assistance on transfer pricing to Kenya and Ghana (separate from but designed to work in conjunction with the Exchange of Information project that DFID is supporting directly for Kenya and Ghana). In addition, a number of instances of technical assistance provided by HMRC have related to transfer pricing. Transfer pricing is also the subject of a small but increasing flow of requests to AFRITACs and FIAS also provides technical assistance in this area.

Question 4: How effective international efforts to promote tax disclosure and transparency are likely to be

48. The work of the Global Forum on Tax Transparency and Exchange of Information at the behest of the G20 has proved very effective at promoting revenue authority to revenue authority disclosure of tax information. The Government believes that this approach, when coupled with appropriate domestic powers to request information, is the most efficient and effective means of enabling tax authorities to obtain the information they need to ensure they can collect the revenue they are owed.

49. The number of Global Forum member countries and the network of tax information exchange agreements has been increasing rapidly and this looks set to continue. An important catalyst in this was the listing process, which the UK supported and which was encouraged by the G20 as part of its work on "non-cooperative jurisdictions". This publicly identified jurisdictions that did not meet the international standard. It was undoubtedly the driving force for a significant change of stance from a number of important financial centres, which engaged with the Global Forum for the first time and agreed to adopt international standards on exchange of information. Although the standard set for reaching the "white-list" was relatively modest, the Global Forum is now carrying out an extensive programme of rigorous peer reviews of countries' implementation and effective operation of tax information exchange. All review reports are available online
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and remedial action has by and large been promptly taken in response to deficiencies identified.

50. Critics of the current system, which is largely based on information exchange on demand via bilateral treaties, argue that multilateral instruments are superior and that automatic exchange of all tax information between all jurisdictions should be the ultimate goal. As noted above, the Convention on Mutual Administrative Assistance in Tax Matters now offers multilateral information exchange for the first time. As regards automatic information exchange, the EU Savings Directive requires automatic exchange of information between tax authorities in participating countries on bank account interest. The Convention however also provides a treaty basis for bilateral automatic exchange of information between signatories should both parties agree to this.

51. Companies and individuals have an important role to play, as was recognised in the report to the Cannes G20 summit by the Development Working Group, which urged multinational companies to "improve transparency and full compliance with applicable tax laws". The UK was also involved in the 2011 updating of the OECD Guidelines for Multinational Enterprises, which state that "It is important that enterprises contribute to the public finances of host countries by making timely payment of their tax liabilities. In particular, enterprises should comply with both the letter and spirit of the tax laws and regulations of the countries in which they operate." This approach was inspired by HMRC’s Banking Code of Conduct for Tax.

52. The model underlying the work of the Global Forum is essentially intergovernmental in nature offering peer-to-peer exchange of information – i.e. between tax authorities. It enables them to obtain detailed and otherwise confidential information about persons of interest – if authority A makes a request to authority B, authority A can in effect benefit from all of the powers of information request and inquiry that authority B has at its disposal, but it must in turn respect confidentiality: this information is not released into the public domain.

53. A well-established model including public disclosure of tax payments (as well as other extractives revenue streams, such as royalty payments) is the EITI, the Extractive Industries Transparency Initiative. The EITI aims topromote accountability for natural resource revenues rather than compliance with tax laws per se.The vast "rents" that are generated in the extractive industries (essentially the difference between the market price for a scarce commodity such as oil and the cost of production) and which largely flow to the government (assuming suitable arrangements are in place) have been seen all too frequently to have a corrosive effect on governance and to feed corruption. Under EITI, extractive industry companies disclose the revenue payments that they make to government in an implementing country, and government discloses the amounts that it has received from companies and there is a reconciliation process to highlight any discrepancies

54. The results of EITI include building trust and dialogue between different stakeholders, improving financial reporting, empowering civil society to hold governments to account and improving the operating environment for private investors
[15]
. An independent evaluation of the EITI in 2011
[16]
found that it had rapidly demonstrated tangible results in the form of financial reconciliation reports and viabile tripartite governance institutions and had led to demand and delivery of transparency and information-based and participatory debate. It recommended that it should consider a Standard that covers a greater part of the value chain and develop further its national and global results framework. These issues are being addressed through the EITI Board’s Strategy Working Group.

55. DFID has provided initial funding to the Natural Resources Charter, which is a wider initiative that aims to improve the management of all parts of the natural resources value chain, from exploration through to the spending of revenues.

56. CoST, the Construction Sector Transparency Initiative, though in detail somewhat different from EITI is also based on the multi-stakeholder model. It is not concerned with the disclosure of tax or other revenues but rather is designed to promote transparency in all stages of the procurement and construction process so as to deliver better value for money, minimise cost overruns and tackle corruption. It is therefore an important initiative as regards ensuring taxpayers money is well-spent. The CoST pilot was funded by DFID and the UK is one of the countries implementing CoST.

57. In addition to its support for EITI, the UK government has expressed its support for regulations at the EU level for mandatory disclosure of payments to governments by extractive industry companies via changes to the Accounting and Transparency Directives. These proposals, currently under discussion in the European Council, seek to replicate, for application across all EU Member States in equal measure, similar measures to those in section 1504 of the Dodd-Frank Act in the US. They aim to complement and reinforce EITI and are, like EITI, aimed at promoting accountability for revenue. The UK government has sought to encourage resource-rich countries to implement EITI and other jurisdictions to introduce mandatory disclosure requirements for companies listed on their stock exchanges.

58. Country-by-country reporting, which is vigorously promoted by some NGOs in the UK and elsewhere, is different again. It is intended to apply to all multinational enterprises (not just those in the extractives sector) and would require a much wider array of data to be disclosed than simply the amounts of tax and related revenue streams, broken down by country of operation. The stated objective of this disclosure model is to allow outside parties to judge whether multinational enterprises are paying the right amount of tax in the countries where they operate – so it is aimed at tax compliance rather than focusing on accountability for revenue, as is the case for EITI and Dodd-Frank-style rules.

59. Country-by-country reporting has been discussed extensively in one of the subgroups of the OECD Tax and Development Task Force (i.e. in a group involving NGOs, business, donors and tax specialists) but the Task Force process has not yet concluded. More broadly, however, there is no international consensus as to whether country-by-reporting can achieve its stated aims and it is not currently a matter highlighted by developing countries themselves. Companies are also concerned about the potential compliance costs. Country-by-country reporting is also promoted as the reporting model that would be required if the current global tax system were replaced with a system of "global formulary apportionment"
[17]
and can perhaps be more readily understood in that context.

Question 5: Capital Flight and its implications for developing countries

60. While there is no commonly agreed definition of capital flight in economic theory, work by the Overseas Development Institute, funded by DFID, defined capital flight as that part of outflow capital which is motivated by economic and political uncertainty. Alternatively, the OECD defines capital flight as "the transfer of assets denominated in a national currency into assets denominated in a foreign currency, either at home or abroad, in ways that are not part of normal transactions".

61. Capital flight can be the result of inaccurate transfer pricing, resulting in the movement of funds intra-group across borders. Capital flight can also be the result of money laundering of the proceeds of illegal activities, including tax evasion, where this laundering process crosses borders (though it is debatable how much of the proceeds of, for example the illegal drug trade, would constitute part of the normal capital stock of a country). Capital flight can also be a "rational portfolio choice" as Paul Collier of Oxford University has described it, where holders of capital choose to move their funds elsewhere for fear of seeing them seized, devalued by currency fluctuations or inflation, or simply because of a lack of investment opportunities in the country.

62. Ways to reduce capital flight from developing countries can include reducing the scope for cross-border tax evasion; tackling criminal activities, and in particular taking action against money laundering; and improving the political and economic variables that constitute the investment climate.

63. Improving tax compliance and reducing tax evasion and avoidance are discussed in the responses to earlier questions. As regards tackling money laundering, DFID has supported a number of interventions in this area, for example providing funding to the Eastern and Southern African Anti-Money Laundering Group and the Inter-Government Action Group against Money Laundering in West Africa (Financial Action Task Force (FATF) style regional bodies) as well as specific country programmes in Nigeria and elsewhere. In terms of tax and money laundering specifically, the UK has also consistently advocated that FATF should, in its current review of its Recommendations, specify that tax offences should count as predicate crimes for money laundering (this would mean that moving the proceeds of tax evasion through the financial system would also count as money laundering, as it already does in the UK, which has an "all-crimes" definition of predicate offences). DFID seeks to trace and return the proceeds of corruption in partner countries that find their way to the UK (another form of capital flight); for example funding the Proceeds of Corruption Unit at the Metropolitan Police as well as a team at the Crown Prosecution Service. A total of over £170 million worth of asset have been restrained, recovered or returned and prosecutions obtained for money-laundering and other offences, most recently of the associates of James Ibori, former governor of Delta State in Nigeria.

[9] 12 of DFID's 27 priority countries have two or more comparable PEFA assessments, enabling changes in PFM performance to be tracked. For 11 of these countries more PEFA indicator scores improved than worsened between assessments and for 1 country, more worsened. Two countries have 3 comparable assessments. One showed continuous net improvement. The other showed improvement between the first 2 assessments and then worsened slightly.

[9]

[10] In this discussion evasion is taken to refer to deliberate, illegal non-compliance (and so would include non-payment of taxes because it is assumed they will be embezzled or misused as well as practices more commonly thought of as evasion) whereas avoidance involves the exploitation of unintended loopholes in regulations. Incorrect transfer pricing is the mispricing of intra-group transactions.

[13] “Action 2: Support work to prevent erosion of domestic tax revenues. We ask the Global Forum to enhance its work to counter the erosion of developing countries’ tax bases and, in particular, to highlight in its report the relationship between the work on non-cooperative jurisdictions and development.”

[17] Global formulary apportionment would allocate the taxable profits of a multinational group among the component enterprises in different countries on the basis of a predetermined formula, for example based on a combination of costs, assets, payroll, and sales.